At Midyear, it’s a Good Time for Investors to Reflect on What Surely Is a DICEY FUTURE : Midyear Investment and Economic Outlook

Financial markets around the globe sent a powerful message to investors large and small in the first half of this year: The easy money days are over.

After a spectacular bull run in stocks and bonds worldwide in 1991, gains so far this year have been much harder to come by--especially for investors who had grown enamored of chasing hot market trends.

Stock rallies have mostly been brief affairs, and the U.S. market can’t make up its mind which industries deserve to lead a new bull move, if indeed there is to be one.

Bond rallies have also been fleeting. Though short-term interest rates have inched down since year’s end, long-term rates are up slightly, mocking the Federal Reserve’s apparent success at keeping inflation subdued.

Meanwhile, the economic backdrop is disconcertingly similar to what it was a year ago. After a relatively strong winter and spring, the economy appears to be faltering. That leaves the outlook for corporate profit and interest rates as uncertain as ever--even without the additional angst caused by the muddled presidential race.

For most individuals, none of this has yet provided a good enough reason to flee stocks and bonds. Indeed, mutual fund companies have been astounded by investors’ staying power during this year’s turmoil.

But midyear provides a needed moment of reflection. If it’s going to be at least as tough to make money in the second half as in the first, now’s the time to take some steps to improve your odds.

Here are eight points to consider as you review your investments and plan new ones in the second half of 1992:

* You’re probably doing better than you think. Many one-shot market gamblers got killed in the first half, but if you own a decent mix of stocks, bonds and/or stock or bond mutual funds, chances are you did OK.

Though many formerly hot stocks crashed--with much publicity--the average New York Stock Exchange issue has slipped just 3.4% in the half. Considering last year’s 27% average gain, the give-back so far isn’t much.

Smaller stocks took bigger hits, but they also gained much more last year. The average small-stock mutual fund is down 8.5% year-to-date, after rocketing 52% in 1991.

Bonds, meanwhile, mostly provided positive returns, even though long-term interest rates inchedup from year-end. The typical fixed-income mutual fund tracked by Lipper Analytical Services is up 3% so far.

The message here for most investors: If you’ve diversified, you haven’t lost your shirt--probably not even your belt.

* A slow economic recovery still looks intact. Despite renewed concerns that the economy is weakening, many Wall Street pros aren’t betting on another recession. More likely, they say, is a continuation of the ebb-and-flow, slow-growth recovery that began 18 months ago.

“Most everything is pointing up, it’s just that the economy hasn’t lifted yet,” says Robert Beckwitt, manager of the Fidelity Asset Manager fund in Boston. He’s willing to wait.

Think of it this way: Bit by bit, more companies and individuals are leaving the debt problems and other baggage of the last few years behind them. It’s a slow process, and there’s still a lot of pain. But one measure of improvement is how business and consumer confidence gauges have risen significantly this year.

A major question is whether companies can make good money in a slow economy. If most can’t, stock prices obviously can’t hold up. Yet investment advisers Bhirud Associates in New York calculate that 62% of major U.S. companies reported better-than-expected first-quarter results. That was an important start, lost in the recent gloom.

* Short-term interest rates won’t rise soon. At least for the next five months--until the election comes and goes--there is little chance that the Federal Reserve will push rates up. If anything, another cut in short-term rates may be imminent to ensure that the economy remains on track.

“I think they’ll move heaven and earth to keep the economy going,” money manager Bill Corneliuson at Strong Funds in Milwaukee says of the Fed.

A continuation of 3.4% annualized yields on money-market funds and short-term bank accounts means investors who stay in those accounts can only hope to earn 1.7% over the next six months. Yet the sum of money in such accounts still is climbing, as uncertainty grounds many anguished savers.

Most of that cash will stay put in the second half, of course. But the harsh reality of a tiny 1.7% return on short-term investments should at least continue to lure some new dollars to stocks and bonds--and justify the decision of most stock and bond investors to hold on.

* Bonds still look good--but a mix is best. As new signs of economic revival appear over the next six months, long-term interest rates may jump for a time. But because yields have remained relatively high all along--even during the recession--they won’t rise dramatically in the early stages of the recovery, many experts argue.

Robert Brusca, economist at Nikko Securities in New York, figures that the yield on 30-year Treasury bonds (now 7.8%) might rise to 8.5% at some point in the next six months. But by then, the increase will start to self-destruct, he says: Higher rates slow the economy, which then reduces inflation fears, which then allows rates to fall back again.

We’ve seen this work for the past five years, in fact. T-bond yields have remained in the relatively narrow range of 7.5% to 9% since 1987.

Rather than the Fed, “It’s the private sector that has its foot on the brake,” Brusca says, because investors quickly mark up interest rates at the first sign of inflation.

For bond investors, the continuation of this pattern should mean you can take home 6% to 9% annual yields on bonds over time without substantial erosion of your principal, because rates can’t go on a sustained rise.

But if you want to own bonds, many pros advise owning a mix of Treasuries, corporates (including junk bonds), foreign bonds and municipals. Each market tends to move independent of the others. Through mutual funds you can own each category or a single fund that mixes each group.

Neta Gagen, a financial planner in Garden Grove, has been moving some of her clients into foreign bond funds lately, on the belief that high interest rates in many foreign countries may be ready to decline even if U.S. rates rise. If foreign rates fall, Gagen notes, the older securities in foreign bond funds can appreciate, giving her investors a capital gain in addition to their interest return.

* Don’t ignore foreign stocks. If you’ve put off investing in foreign stocks even though you knew better, the first half of this year should get you moving. Many foreign stock markets provided substantially better returns than the U.S. market--Japan being the notable exception.

In the second half, foreign markets face as much uncertainty as the U.S. market. But if you invest only in U.S. stocks, you’re missing out on 60% of the world’s stock opportunities, experts note.

To dramatize the growth opportunities available abroad, financial planner Gagen reminds apprehensive clients that “where the U.S. was at at the start of the 20th century is where much of the rest of the world is now.”

As with bonds, mutual funds make it easy to own a diversified portfolio of foreign stocks, managed by a professional.

* With U.S. stocks, value is what counts now. Wall Street’s first-half performance showed that stocks don’t necessarily stay high-priced just because short-term interest rates are low. While investors in 1991 bid up many stocks to stratospheric levels, a new sobriety settled in during the first half of this year, and more than a few of the high-fliers plummeted.

Retailer Gap Inc. illustrates the change in investors’ attitude. Near the start of the year, the stock sold for $59, or 37 times last year’s earnings per share of $1.62. But as the months passed, investors began to realize that tight-fisted consumers in a weak economy would mean slower growth even for a star retailer such as Gap.

Today, the stock sells for about $32, down nearly 50% from its peak. Gap may yet show better earnings growth than most companies, but investors have made a collective decision that seems likely to stick: In a slow economy and a nervous stock market, you can’t afford to overpay for a stock.

A stock’s price versus earnings per share--the “P-E”--is a basic yardstick of value and risk. Though not infallible, it imparts a simple message: If most stocks usually trade for 10 to 20 times earnings, a stock trading for 30, 40 or 50 times earnings must deliver fantastic growth--or it will crash.

* Value is where you find it. Investors often confuse the debate between value stocks and so-called growth stocks as a debate between grungy, unloved industries such as steel versus more glamorous businesses such as health care.

In fact, any stock large or small can be a “value.” The key is that the decision to buy or hold the stock must be based on some common-sense parameters about risk versus return.

Nick Whitridge, manager of the $33-million Babson Value mutual fund in Boston, has loaded his portfolio with such stocks as General Motors, J. C. Penney, IBM and Dow Chemical. So far this year his fund is up 8%, while most stock indexes are down.

Whitridge says his stocks are bets on a continuing economic recovery, yet at still-reasonable prices relative to the companies’ expected earnings this year. “These stocks are selling for an average price-to-earnings ratio of 12 times 1992 results, compared to about 17 times earnings for the market overall,” he says.

Late last year, many investors somehow considered these stocks too risky--while at the same time lining up to pay 100 or more times earnings for fledgling biotechnology companies. Since then, of course, most biotech stocks have plunged 30% to 70%.

“I view what’s going on in the market as a readjustment of values that got too far out of whack,” Whitridge says simply. What’s important for investors to understand, he adds, is that the market’s shift to a value mind-set isn’t likely to pass quickly; it may in fact last years.

* Value investing requires patience. When an investor gets serious about paying only fair prices for stocks, something else usually accompanies that decision: A willingness to wait for results.

The St. Louis-based Lindner Fund is a classic old-time value stock fund. In the 15 years ended last Dec. 31, the fund’s return to its investors was 1,459%, or nearly twice the 745% return of the average stock mutual fund. But in any given year, Lindner typically is the tortoise fund among the hares. Its stocks remain in the portfolio for an average seven years, while most funds turn their holdings over two to three times in any 12-month period.

Fund manager Robert Lange advises investors to forget the fast-buck markets of 1991 and most of the 1980s. A return to value investing means a return to long-term investing--which is the reason the stock market exists in the first place, he says.

“People have gotten used to making a quick buck--but that’s the unusual thing in the stock market,” not the norm, Lange says.

Cash Still Builds Up. . . Despite the sharp drop in short-term interest rates, investors continue to pump cash into short-term bank and money-market accounts--apparently waiting for rates to rise again. Source: Federal reserve Bank of St. Louis

. . .But It Pays To Move On In the 20 years ended June 1, short-term investments--as measured by returns on 3-month Treasury bills--lagged returns on stocks and bonds. (20 year average returns) Stocks: 11.5% Bonds: 9.3% Gold: 9.2% T-Bills: 8.6% Housing: 7.1% Inflation: 6.3% Source: Salomon Bros.

. . .Yet U.S. Stocks Wilt Year-to-date percent change U.S. Indexes Dow Industrials: +3.6 S&P; 500: -3.3 Wilshire 5,000: -4.2 NASDAQ Composite: -6.6 S&P; Mid-cap: -7.4

. . .So Investors Go Overseas Year-to-date percent return to U.S. investors Foreign Stock Markets (Returnds adjusted for currency fluctuations) France: 10.2 Germany: 7.1 Britain: 3.5 Sweden: 2.4 Singapore/Malaysia: 1.8 Sources: Federal Reserve Bank of St. Louis, Los Angeles Times and Morgan, Stanley Capital International